On the heels of recent actions by Canadian regulators and the U.S. SEC, some countries may be regulating digital currency as securities.
The market for digital currencies has taken off faster than regulatory agencies could keep pace. With favored currencies like Bitcoin trading at a record high of $4,700 as of Aug. 29 and a robust international market emerging, these agencies are making moves to regulate initial coin offerings (ICOs), the way by which cryptocurrency ventures raise funds.
One method gaining steam is to regulate some ICOs under existing securities law. On July 25, the U.S. Securities and Exchange Commission (SEC) issued guidance stating that federal securities laws apply to ICOs, while Singapore quickly followed suit, deciding it will regulate ICOs under securities law. On Aug. 24, Canada made its move, with the Canadian Securities Exchange Administrators (CSA) announcing that securities laws may apply to ICOs.
Canada’s move is “entirely consistent with what’s happening here in the States,” said Stephen Obie, partner at Jones Day. Obie represents Overstock.com’s financial technology subsidiary t0.com in its use of blockchain technology. “Canadian regulators are reaffirming that ICOs can be securities and that folks need to be cautious and evaluate what sort of ICO they’re launching.”
Digital coins have until this August been unregulated and, when traded, did not confer ownership rights. Digital currency sales have also been frequently cited as subject to fraud. On Aug. 28, the SEC issued an investor alert warning investors of “ pump-and-dump” schemes (artificially inflating a share price by encouraging investors to purchase to sell one’s own shares at a high price) and market manipulations.
The alert followed the SEC’s trading suspension of shares from four companies with coin offerings. One of those companies, First Bitcoin Capital Corp., is headquartered in Vancouver, British Columbia. The CSA issued its guidance on coin offerings a day after the SEC issued its suspension of the company as well as its investor alert.
Joshua Klayman, of counsel in the financial transactions group at Morrison Foerster, wrote in a LinkedIn post that “it is interesting to consider” whether the SEC Investor Alert was partially motivated by a First Bitcoin Capital letter to shareholders suggesting that the SEC action was a “misunderstanding,” and potentially motivated by a need to curb demand for shares. She wrote:
“Could it be that the SEC’s Investor Alert was released, in part, to combat communications, like the BITCF Letter, that seeks to minimize the gravity of a temporary trading suspension? Perhaps.”
Regarding the CSA’s announcement, Klayman told Legaltech News that she “had no idea” whether the timing was a coincidence. However, she said, given that three countries have already regulated coins as securities, more countries are going to potentially come out with similar guidance.
“I think that will have an effect, because it will cause people to take greater caution when they are developing these types of structures for their token sales,” she explained. “It certainly should give lawyers pause when they’re advising on these to say, ‘Listen, you really need to take a hard look at this and think about whether you just want to assume it’s a security.’”
Klayman noted that, while “many people would advise to take a conservative view anyway” in these investments, “the more and more guidance comes out, the less and less easy it is for people with a straight face around the world to say, ‘My jurisdiction says it’s not a security; who cares about what other jurisdictions think.’”
Klayman added that early token sales may have been launched under the belief that they “might be OK where they are, but they’re pretty much floating securities law in every jurisdiction. [That's] no longer something you can say with a straight face.”
Other countries have been known to be loosely regulated when it comes to ICOs. Switzerland for example, has been touted as a cryptocurrency haven of sorts, with the city of Zug being dubbed “Crypto Valley.” Others, such as Gibraltar and Luxembourg, are known to have frameworks friendly toward cryptocurrency investment. Internationally, the market is highly speculative. Cambridge Center for Alternative Finance bitcoin expert Garrick Hileman told Vox that speculation was “the primary driver” of increasing bitcoin value.
Prior to SEC clarification, regulations around coins were precarious at best. In December 2016, Overstock became the first company to have a fully regulated public coin offering in the U.S. Discussing his experience with regulators, John Tabacco, co-founder of Overstock subsidiary T0, told an audience at a Morrison Foerster event, “At that time, a lot of people were trying to go around the edges: Is it crowdfunding, it’s not a security, is it a security, blah, blah, blah.”
He noted that the company used Jones Day as counsel and that he was ordered to “spend whatever needs to be spent to go straight into the front doors of the SEC, tell them what we’re doing and keep letting them tell you why you can’t do it. And then address those gaps as you go along. And then when we’re done and they have no more questions, we’re going to be the first company to do an offer.” This, he added, was why the company had the first public offering.
Speaking about the SEC’s advisory on pump-and-dump schemes, Jones Day’s Obie said, “It doesn’t surprise me that what’s happening here is there’s a regulatory effort to raise awareness about the potential in the ICO marketplace. What folks are trying to say is that laws that have existed for decades still apply, and anyone buying these coins should definitely do their due diligence. It’s not for the faint of heart at times.”
As to whether regulating ICOs under securities law will have any dramatic impact on businesses, Daniel Wheeler, partner at Bryan Cave, said that, going forward, he would expect “legitimate operators” to “spend a lot of money, do it the right way. And I would think that should be a signal to investors that anyone who is not doing it that way is a boiler room pump-and-dump operation.”
Wheeler said he thinks this will lead to fewer ICOs, as the market “should understand now that doing one is just as expensive as any other security.”